16.1G: Informal Economy

The informal economy consists of economic activity that is neither taxed nor regulated by a government.

LEARNING OBJECTIVES

Analyze the impact of the informal economy on formal economy, such as the black market or working “under the table”

KEY TAKEAWAYS

Key Points

Informal economies include economic practices that are not included in the calculation of GNP (the market value of all products and services produced by a country’s companies in a given year).

Participation in the informal economy may result from lack of other options (e.g. people may buy goods on the black market because these goods are unavailable through conventional means). Participation may also be driven by a wish to avoid regulation or taxation.

The growth of the informal economy is often attributed to changing social or economic environments. For example, with the adoption of more technologically intensive forms of production, many workers have been forced out of formal sector work and into informal employment.

Growing regulation and taxation may also force people into the informal economy.

The informal economy accounts for about 15 percent of employment in developed countries such as the United States.

Key Terms

Progressive Era: The Progressive Era in the United States was a period of social activism and political reform that flourished from the 1890s to the 1920s.

industrial paternalism: Industrial paternalism is a form of welfare capitalism especially common in the United States. It refers to the practice of businesses providing welfare-like services to employees.

welfare capitalism: Welfare capitalism refers either to the combination of a capitalist economic system with a welfare state or, in the American context, to the practice of businesses providing welfare-like services to employees.

The informal economy consists of economic activity that is neither taxed nor regulated by a government. This is in contrast to the formal economy; a formal economy includes economic activity that is legal according to national law. Formal economy goods may be taxed and are included in the calculation of a government’s gross national product (GNP), which is the market value of all products and services produced by a country’s companies in a given year. Informal economies are frequently less institutionalized and include all economic practices that are not included in the calculation of GNP. Informal economies therefore include such disparate practices as the drug trade and babysitting—anything that isn’t reported to the government or factored into the nation’s GNP. All economies have informal elements.

Drugs in the Informal Economy: Dealing drugs is an example of participation in the informal economy.

The original use of the term ‘informal sector’ is attributed to the economic development model put forward by W. Arthur Lewis, used to describe employment or livelihood creation and sustainability primarily within the developing world. It was used to describe a type of employment that was viewed as falling outside of the modern industrial sector. Participation in the informal economy may result from lack of other options (e.g. people may buy goods on the black market because these goods are unavailable through conventional means). Participation may also be driven by a wish to avoid regulation or taxation. This may manifest as unreported employment, hidden from the state for tax, social security or labor law purposes, but legal in all other aspects.

The growth of the informal economy is often attributed to changing social or economic environments. For example, with the adoption of more technologically intensive forms of production, many workers have been forced out of formal sector work and into informal employment. Arguably the most influential book on informal economy is Hernando de Soto’s The Other Path. De Soto and his team argue that excessive regulation in the Peruvian (and other Latin American) economies force a large part of the economy into informality and thus prevent economic development. In a widely cited experiment, his team tried to legally register a small garment factory in Lima. This took more than one hundred administrative steps and almost a year of full-time work. Whereas de Soto’s work is popular with policymakers and champions of free market policies, many scholars of the informal economy have criticized it both for methodological flaws and normative bias.

The informal economy accounts for about 15 percent of employment in developed countries such as the United States. By contrast, it makes up 48 percent of non-agricultural employment in North Africa, 51 percent in Latin America, 65 percent in Asia, and 72 percent in sub-Saharan Africa. If agricultural employment is included, the percentages rise—beyond 90 percent in places like India and many sub-Saharan African countries.

Burkina Faso: Informal economy at the centre of solidarity: Many workers in Burkina Faso participate in the country’s informal economy. This video describes how the informal economy fails to provide some of the same social benefits as work in the formal economy.

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